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FHLB-Chicago Skating on Very Thin Ice

Posted by Larry Doyle on August 5, 2009 4:21 PM |

The Federal Home Loan Bank (FHLB) system represents significant risks within our financial system. The fact that you do not hear about this system does not mean the risks are shallow or insignificant. You do not hear about the FHLB system simply because the general media pays no attention to it. They should.

Thanks to a close friend for sharing a recent FHLB-Chicago Presentation. This overview provides the following:

1. market update
2. financial results
3. developments in products, credit, and collateral
4. future outlook

Based on my experience, the FHLB-Chicago was always one of the more conservatively managed banks within the FHLB system. That said, after reviewing their financials it is very apparent that this bank is skating on very thin ice and if not for the relaxation of the mark-to-market by the FASB would be well below regulatory capital standards.

For those intrigued by the inner workings of a FHLB, this review provides riveting details. If you are looking for the Cliff Notes, allow me to highlight:

Pages 27-28
The Net Income Statement for ytd 2009 and comparable period in 2008 displays the enormous benefit of the relaxation of the mark-to-market accounting standard as the bank swings from a $152 million loss in 2008 to a $64million gain for ytd 2009.

Pages 35-36
The regulatory capital ratios for FHLB-Chicago highlight that this entity has approximately a mere $200 million in excess capital above the minimum requirement. For an entity this size, $200 million is razor thin.

Page 39
impairment of this bank’s assets is truly mind boggling. As of year end 2007, the FHLB-Chicago viewed 100% of their assets as being AAA. Fast forward a mere 18 months, now 35% of these assets are rated CCC or worse. Please review the graph on this page for a hint as to the destructive nature of these ratings downgrades on this bank. FHLB-Chicago is representative of many financial entities in our banking system today. No surprise why so many are failing and will continue to fail. This graph is very powerful.  What do you think the bid is for that CCC bucket of assets right now? Zero or very close.

Page 40
The FHLB-Chicago highlights that they have taken writedowns of $263 million on their assets due to credit impairments while they still view potential writedowns of $1.213 billion on these assets due to market conditions.

Given that the FHLB-Chicago admittedly has a mere $200 million in excess capital to satisfy the minimum regulatory capital ratio, we can see that without the relaxation of the mark-to-market they would be woefully capital deficient.

Is the housing market going to improve markedly so that their assets will dramatically increase in value, especially that 35% in the CCC bucket? I would not bet on it.

. . . and the FHLB-Chicago is one of the better managed.


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